Japan Is Counting on Shareholder Activism to Improve Its Economy

Executive Summary

The case for shareholder activism is perhaps best seen in Japan, where the corporate sector tends to be structurally skewed in favor of employees, at the expense of shareholders and the economy. In Japan, several factors combine to help insulate managers from outside influence, including cross-holdings where the company owns shares in a partner firm, docile boards mostly comprised of company executives, and a court system historically biased against investment funds. In Japan, the worry lately has been not too much shareholder activism, but too little. Remarkably, Prime Minister Abe has embraced shareholder activism, in a bid to encourage the adoption of his corporate governance reforms, a central part of his economic policy platform.

Shareholder activism is a quintessentially American form of investing. In the U.S., CEOs live in fear of activist hedge funds, and politicians worry about their effects on workers. But the case for shareholder activism is perhaps best seen in Japan, where the corporate sector tends to be structurally skewed in favor of employees, at the expense of shareholders and the economy. In Japan several factors combine to help insulate managers from outside influence, including cross-holdings where the company owns shares in a partner firm, docile boards mostly composed of company executives, and a court system historically biased against investment funds. In Japan the worry lately has not been about too much shareholder activism but about too little. Remarkably, Prime Minister Shinzo Abe has embraced shareholder activism, in a bid to encourage the adoption of his corporate governance reforms, a central part of his economic policy platform.

The governance shortcomings of the Japanese corporate sector are core to the sclerosis experienced by the economy since the 1980s. The Abe administration’s corporate governance reforms attempt to remedy this lack of dynamism in various ways. While it has explicitly encouraged both more shareholder-friendly governance by companies and greater engagement from institutional investors, it has implicitly supported shareholder activism as a forcing mechanism. Reform is the carrot; activist investors are the stick.

Recognizing that getting Japanese institutional investors to pressure companies to implement changes that run counter to decades of cozy understanding will be, at best, a slow process. The Abe administration has created the conditions for smaller, nimbler funds — typically independent of large Japanese institutions — to push forward its corporate agenda, one company at a time. Uncharacteristically, the administration seems unconcerned by the fact that many of these funds are foreign. In fact, the government-run GPIF, Japan’s largest pension fund, has invested in Taiyo Pacific, an American activist fund targeting Japanese companies. Abe has even met with one of the most prominent American activists, Dan Loeb, in a private albeit well-publicized encounter, suggesting he sees value in foreign involvement in Japanese markets.

The more positive public perception of activists in Japan marks a dramatic change. In the 2000s a wave of activists targeted Japanese-listed companies, typically adopting confrontational approaches similar to those prevalent in the United States. By and large, they failed. Whether they were Western funds, such as Steel Partners and TCI, or Japanese funds, such as Murakami, they found that the entire system conspired to support the embattled companies, no matter how impaired their corporate governance. At the time, activists were seen as bullies and pariahs. Today they’re seen as part of the solution, in part because they’ve changed tactics.

Since the global financial crisis, a new wave of “constructive,” or friendly, activists (typically referred to as engagement funds) has tackled the same corporate governance issues, but with an explicitly low-key, humbler approach. Rather than berating management publicly, these funds have led quiet discussions behind closed doors. They earn senior managers’ trust by demonstrating their patience and, more often than not, refraining from asking for board seats or challenging them in proxy fights. They seek to win management over by sharing well-researched analysis and connecting them to a network of potential partners. Pioneer funds of this approach include Asuka Value-up, Taiyo Pacific, and Simplex Asset Management. (Full disclosure, I am involved in this strategy as part of Cornwall Capital). Even traditionally confrontational activists such as Third Point have shifted their strategy in Japan to adopt a more constructive approach.

Since the launch of Abe’s Corporate Governance and Stewardship Codes, the number of constructive activists in Japan has proliferated. Whereas activists in Japan have historically been treated with scorn for attempting to extract value from the system, they can now point to the fact that their actions are consistent with the government’s policy goals.

More important, companies are increasingly tuned into the Corporate Governance Code. In my own experience, many companies have gone from being completely oblivious to being solicitous of investors’ perspective on the code. A subset of companies has become less suspicious of engagement funds. Optimists perceive the emergence of a snowball effect. Other countries with dormant, overprotected corporate sectors should take heed of Japan’s experiment in the use of shareholder activism as a policy tool.

JC de Swaan is a partner at Cornwall Capital and a lecturer in economics at Princeton University.